Chapter 4 –

Financial Forecasting,
Planning, and Budgeting

 2005, Pearson Prentice Hall

 Financial Forecasting

1) Project sales revenues and expenses.

 Financial Forecasting

1) Project sales revenues and expenses.

2) Estimate current assets and fixed
assets necessary to support projected
sales.
 Financial Forecasting

1) Project sales revenues and expenses.

2) Estimate current assets and fixed
assets necessary to support projected
sales.
3) Determine the firms financing needs
throughout the planning period
 Percent of sales forecast
 Percent of sales forecast

involves estimating the level of an expense,

asset, or liability for a future period as a
percent of the forecast for sales revenues
 Percent of Sales Method

 Suppose this year’s (2008)sales

total $32 million.
 Next year (2009), we forecast
sales of $40 million.
 Net income should be 5% of sales.
 Dividends should be 50% of
earnings.
 This year(2008)
Assets
Current Assets $8m
Fixed Assets $16m
Total Assets $24m
Liab. and Equity
Accounts Payable $4m
Accrued Expenses $4m
Notes Payable $1m
Long Term Debt $6m
Total Liabilities $15m
Common Stock $7m
Retained Earnings $2m
Equity $9m
Total Liab. & Equity $24m
 STEP 1:

compute the percentage of B.S.

items( which varies with sales) to
this year sale ($32 million)
 This year(2008) % of $32m
Assets
Current Assets $8m (8/32) =25%
Fixed Assets $16m (16/32) =50%
Total Assets $24m
Liab. and Equity
Accounts Payable $4m (4/32) =12.5%
Accrued Expenses $4m (4/32) =12.5%
Notes Payable $1m n/a
Long Term Debt $6m n/a
Total Liabilities $15m
Common Stock $7m n/a
Retained Earnings $2m
Equity $9m
Total Liab. & Equity $24m
 STEP 2:

Prepare the next year B.S(2009) by

multiply the percentage time the
forecast sale ($40 million
 Next year(2008) % of $40m
Assets
Current Assets 25%
Fixed Assets 50%
Total Assets
Liab. and Equity
Accounts Payable 12.5%
Accrued Expenses 12.5%
Notes Payable n/a
Long Term Debt n/a
Total Liabilities
Common Stock n/a
Retained Earnings
Equity
Total Liab. & Equity
 Next year % of $40m
Assets
Current Assets (40m*25%) $10m 25%
Fixed Assets 50%
Total Assets
Liab. and Equity
Accounts Payable 12.5%
Accrued Expenses 12.5%
Notes Payable n/a
Long Term Debt n/a
Total Liabilities
Common Stock n/a
Retained Earnings
Equity
Total Liab. & Equity
 Next year % of $40m
Assets
Current Assets (40m*25%) $10m 25%
Fixed Assets (40m*50%) $20m 50%
Total Assets
Liab. and Equity
Accounts Payable 12.5%
Accrued Expenses 12.5%
Notes Payable n/a
Long Term Debt n/a
Total Liabilities
Common Stock n/a
Retained Earnings
Equity
Total Liab. & Equity
 Next year % of $40m
Assets
Current Assets (40m*25%) $10m 25%
Fixed Assets (40m*50%) $20m 50%
Total Assets $30m
Liab. and Equity
Accounts Payable 12.5%
Accrued Expenses 12.5%
Notes Payable n/a
Long Term Debt n/a
Total Liabilities
Common Stock n/a
Retained Earnings
Equity
Total Liab. & Equity
 Next year % of $40m
Assets
Current Assets (40m*25%) $10m 25%
Fixed Assets (40m*50%) $20m 50%
Total Assets $30m

Liab. and Equity

Accounts Payable (40m*12.5%) $5m 12.5%
Accrued Expenses 12.5%
Notes Payable n/a
Long Term Debt n/a
Total Liabilities
Common Stock n/a
Retained Earnings
Equity
Total Liab. & Equity
 Next year % of $40m
Assets
Current Assets (40m*25%) $10m 25%
Fixed Assets (40m*50%) $20m 50%
Total Assets $30m

Liab. and Equity

Accounts Payable (40m*12.5%) $5m 12.5%
Accrued Expenses (40m*12.5%) $5m 12.5%
Notes Payable n/a
Long Term Debt n/a
Total Liabilities
Common Stock n/a
Retained Earnings
Equity
Total Liab. & Equity
 Next year % of $40m
Assets
Current Assets (40m*25%) $10m 25%
Fixed Assets (40m*50%) $20m 50%
Total Assets $30m

Liab. and Equity

Accounts Payable (40m*12.5%) $5m 12.5%
Accrued Expenses (40m*12.5%) $5m 12.5%
Notes Payable $1m n/a
Long Term Debt n/a
Total Liabilities
Common Stock n/a
Retained Earnings
Equity
Total Liab. & Equity
 Next year % of $40m
Assets
Current Assets (40m*25%) $10m 25%
Fixed Assets (40m*50%) $20m 50%
Total Assets $30m

Liab. and Equity

Accounts Payable (40m*12.5%) $5m 12.5%
Accrued Expenses (40m*12.5%) $5m 12.5%
Notes Payable $1m n/a
Long Term Debt $6m n/a
Total Liabilities
Common Stock n/a
Retained Earnings
Equity
Total Liab. & Equity
 Next year % of $40m
Assets
Current Assets (40m*25%) $10m 25%
Fixed Assets (40m*50%) $20m 50%
Total Assets $30m

Liab. and Equity

Accounts Payable (40m*12.5%) $5m 12.5%
Accrued Expenses (40m*12.5%) $5m 12.5%
Notes Payable $1m n/a
Long Term Debt $6m n/a
Total Liabilities $17m
Common Stock n/a
Retained Earnings
Equity
Total Liab. & Equity
 Next year % of $40m
Assets
Current Assets (40m*25%) $10m 25%
Fixed Assets (40m*50%) $20m 50%
Total Assets $30m

Liab. and Equity

Accounts Payable (40m*12.5%) $5m 12.5%
Accrued Expenses (40m*12.5%) $5m 12.5%
Notes Payable $1m n/a
Long Term Debt $6m n/a
Total Liabilities $17m
Common Stock $7m n/a
Retained Earnings
Equity
Total Liab. & Equity
 STEP3:
Predicting Retained Earnings
 Next year’s projected retained earnings =

returned earnings this year (2008)+ predicted return

earnings returned earnings (2009) =
$2 million + ?
 Predicting Retained Earnings

returned earnings this year (2008)+ predicted return

earnings returned earnings (2009) =
$2 million +

[projected x net income x ( 1 - cash dividends) ]

sales projected sales net income
 Predicting Retained Earnings
projected net income cash dividends
sales
x
sales
x(1- net income
)

$40 million x 2m x (1 – 1m) =

40 m 2m

Notes:
net income= 40 m x 5%= 2m
cash dividends= 2m x 50%= 1m
 Predicting Retained Earnings
projected x 1
net income x ( - cash dividends )
sales sales net income

$40 million x 2m x (1 – 1m ) =
40 m 2m

$40 million x 0.05 x (1 - .50) = $1 million

that is predicted return earnings returned

earnings (2008)= 1m
 Predicting Retained Earnings

 Next year’s projected retained earnings = last

year’s $2 million(2008), plus : predicted return
earnings returned earnings (2009)

$2 million + $1 million = $3 million

 Next year % of $40m
Assets
Current Assets (40m*25%) $10m 25%
Fixed Assets (40m*50%) $20m 50%
Total Assets $30m

Liab. and Equity

Accounts Payable (40m*12.5%) $5m 12.5%
Accrued Expenses (40m*12.5%) $5m 12.5%
Notes Payable $1m n/a
Long Term Debt $6m n/a
Total Liabilities $17m
Common Stock $7m n/a
Retained Earnings $3m
Equity
Total Liab. & Equity
 Next year % of $40m
Assets
Current Assets (40m*25%) $10m 25%
Fixed Assets (40m*50%) $20m 50%
Total Assets $30m

Liab. and Equity

Accounts Payable (40m*12.5%) $5m 12.5%
Accrued Expenses (40m*12.5%) $5m 12.5%
Notes Payable $1m n/a
Long Term Debt $6m n/a
Total Liabilities $17m
Common Stock $7m n/a
Retained Earnings $3m
Equity
Total Liab. & Equity
 Next year % of $40m
Assets
Current Assets (40m*25%) $10m 25%
Fixed Assets (40m*50%) $20m 50%
Total Assets $30m

Liab. and Equity

Accounts Payable (40m*12.5%) $5m 12.5%
Accrued Expenses (40m*12.5%) $5m 12.5%
Notes Payable $1m n/a
Long Term Debt $6m n/a
Total Liabilities $17m
Common Stock $7m n/a
Retained Earnings $3m
Equity $10m
Total Liab. & Equity
Equity
Total Liab. & Equity $27m
 Next year % of $40m
Assets
Current Assets $10m 25%
Fixed Assets $20m 50%
Total Assets $30m
Liab. and Equity
Accounts Payable $5m 12.5%
Accrued Expenses $5m How much
12.5%
Notes Payable $1m Discretionary
n/a
Long Term Debt $6m Financing
n/a
Total Liabilities $17m will we
Common Stock $7m Need?
n/a
Retained Earnings $3m
Equity $10m
Total Liab. & Equity $27m
 Next year % of $40m
Assets
Current Assets $10m 25%
Fixed Assets $20m 50%
Total Assets $30m
Liab. and Equity
Accounts Payable $5m 12.5%
Accrued Expenses $5m How much
12.5%
Notes Payable $1m Discretionary
n/a
Long Term Debt $6m Financing
n/a
Total Liabilities $17m will we
Common Stock $7m Need?
n/a
Retained Earnings $3m
Equity $10m
Total Liab. & Equity $27m
 Next year % of $40m
Assets
Current Assets $10m 25%
Fixed Assets $20m 50%
Total Assets $30m
Liab. and Equity
Accounts Payable $5m 12.5%
Accrued Expenses $5m How much
12.5%
Notes Payable $1m Discretionary
n/a
Long Term Debt $6m Financing
n/a
Total Liabilities $17m will we
Common Stock $7m Need?
n/a
Retained Earnings $3m
Equity $10m
Total Liab. & Equity $27m
 STEP4
Predicting Discretionary
Financing Needs
 Predicting Discretionary
Financing Needs

Discretionary Financing Needed =

 Predicting Discretionary
Financing Needs

Discretionary Financing Needed =

projected projected projected

total - total - owners’
assets liabilities equity
 Predicting Discretionary
Financing Needs

Discretionary Financing Needed =

projected projected projected

total - total - owners’
assets liabilities equity

$30 million - $17 million - $10 million

 Predicting Discretionary
Financing Needs
Discretionary Financing Needed =

$30 million - $17 million - $10 million

= $3 million in discretionary financing

Sustainable Rate of Growth
 Sustainable Rate of Growth
 Maximum rate of growth a firm can sustain
without increasing financial leverage and
without having to sell new common stock.
Sustainable Rate of Growth
g* = ROE (1 - b) where
Sustainable Rate of Growth
g* = ROE (1 - b) where

b = dividend payout ratio

(dividends / net income)
Sustainable Rate of Growth
g* = ROE (1 - b) where

b = dividend payout ratio

(dividends / net income)
ROE = return on equity
(net income / common equity) or
 Sustainable Rate of Growth
g* = ROE (1 - b) where

b = dividend payout ratio

(dividends / net income)
ROE = return on equity
(net income / common equity) or

net income sales assets

ROE = sales x assets x common equity
 Budgets

 Budget: a forecast of future events.

 Budgets

 Budgets indicate the amount and

timing of future financing needs.
 Budgets provide a basis for taking
corrective action if budgeted and
actual figures do not match.
 Budgets provide the basis for
performance evaluation.